BERKO: Passive fund management gives superior results
Friday, July 27, 2012 7:00 AM
Dear Mr. Berko:
I’m a teacher with a pension plan, and my contributions are invested in mutual funds I don’t know a darn thing about. Nobody will give us any investment help, so 15 years ago, I started deducting money for five funds that sounded good, and still own them. The performance sucks. None of the funds have done as well as the Standard & Poor’s 500, and I’ve asked the plan administrator for investment help, but they just send me papers I don’t understand. What can I do?
R.D., Chicago, Ill.
I feel bad for millions of investors who put retirement money in funds actively by Fidelity, Franklin, TIAA-CREF, Vanguard, American Funds, Blackrock, Allianz, etc. I feel bad because they don’t know “boo” about their fund choices and are stuck behind the 8-ball. I feel bad because employers give participants a bewildering selection of alternatives, none of which match the long-term performance of their benchmark averages. And I feel bad because the performance of those actively managed, high-cost funds (about 1.5 percent annually) can’t hold a candle to the passively managed, low-cost (about 0.25 percent annually) index funds. If possible, move your 403(b) to Vanguard or Schwab or Fidelity and have an adviser help you select several pure index funds.
Few investors realize that passively managed index funds are superior investments to actively managed funds. Retirement plans own $3.2 trillion in actively managed funds producing $41 billion in annual management fees, versus about $6 billion if that money was invested in passively managed index funds. Wall Street hides this fact from a trusting public who unwittingly pays these enormous annual fees.
Look what Bill Miller, the legendary active manager of Legg Mason’s Value Trust, accomplished between 1991 and 2005. Miller, arguably the finest fund manager of the last 50 years, beat the S&P 500 for 15 consecutive years. Not a single active fund manager has come within a kilometer of matching Miller’s record. Yet Wall Street’s effective PR machine regales the financial media with their latest phenoms, all of whom fumble their picks after a year or three, then fall flat on their bums. In the process of managing this $3.2 trillion, active fund managers may hold cash, invest in any stock or bond they wish or buy and sell any investment as frequently as they want.
By contrast, passively managed index funds must mimic their benchmarks with every tick and tock. The passively managed S&P 500 Index Fund (SPY-$137.95) must at all times remain 100 percent invested in each of the 500 issues in the index. So when Countrywide, Enron, GM, FNMA, and others imploded, passively managed index funds had to stay the course and hold their noses while active fund managers were free to sell those shares. Few did.
So given all of this, isn’t it reasonable to assume that actively managed funds would perform better than passively managed funds? Merrill, Goldman, Blackrock and J.P. Morgan want you to think so, because $41 billion is $35 billion more than $6 billion.
Meanwhile, it’s futile trying to select winners by choosing actively managed funds with superior two- or three-year performance records. So Wall Street hides its many disasters by merging them into better-performing funds. According to S&P, nearly 36 percent of actively managed funds in the last five years were either merged or shut down. And when bad funds die along with their dismal records, the remaining funds look even better. Most investors will have significantly better results if allowed to invest in low-cost index funds.
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